Morgan Stanley pushes Fed cut forecast to Jan/March 2027, citing sticky inflation and hawkish FOMC drift. Euro seen decoupled from rate differentials on Middle East risk; dollar safe-haven bid dominates. Terminal rate seen at 3.0-3.25% Justin had the breaking on this yesterday:Morgan Stanley scraps call for Fed rate cuts this yearMore detail now: Summary:Morgan Stanley has revised its Federal Reserve forecast, dropping expected September and December 2026 cuts and now looking for two 25 basis point reductions in January and March 2027, with a terminal range of 3.0% to 3.25%The revision follows the April FOMC meeting, at which three board members dissented in favour of removing the easing bias entirely, and the statement upgraded its inflation characterisation from "somewhat elevated" to "elevated"Chief economist Michael Gapen wrote that the committee is moving from an easing bias toward a neutral stance, with disinflation needing to be proven before cuts can be justifiedRate futures now price an 83.6% probability of no change through year-end, up from 75.9% the prior week, per CME FedWatch dataMorgan Stanley's base case for eventual cuts rests on expected deceleration in core inflation as the tariff impulse fades, shelter inflation slows and seasonal factors weigh on sequential readings through the rest of 2026The bank flagged that if oil prices remain elevated without signs of normalisation, energy spillovers into core inflation could prove more significant than currently anticipatedOn foreign exchange, Morgan Stanley strategists said the euro against the dollar has decoupled from interest rate differentials and is currently driven by Middle East developments and the dollar's safe-haven statusThe bank expects rate differentials to reassert themselves once the conflict de-escalates; a US-Iran deal could push the euro toward $1.12, but a broader Gulf stabilisation would ultimately favour the euro given the yield shift underwayMarkets are currently pricing 83 basis points of ECB rate hikes in 2026The April meeting was the last to be chaired by Powell before Kevin Warsh is expected to take over subject to Senate confirmationThe euro has broken from its traditional relationship with interest rate differentials and is trading instead on the pull of Middle Eastern geopolitics and the dollar's safe-haven appeal, according to Morgan Stanley's foreign exchange strategists. The finding, buried at the foot of a broader rates research note, may be the most structurally consequential observation in the report.In normal conditions, the euro against the dollar tracks closely with the spread between US and European yields. That relationship has temporarily broken down. With tensions in the Strait of Hormuz keeping risk sentiment fragile, investors are reaching for the dollar regardless of where yields are heading. Rate markets are currently pricing 83 basis points of European Central Bank hikes in 2026, a significant tightening path that would ordinarily support the euro, yet the currency remains capped by safe-haven dollar demand.Morgan Stanley expects the dynamic to shift once the geopolitical backdrop stabilises. A US-Iran agreement could push the euro to $1.12, but beyond that, the firm believes the ongoing yield shift will ultimately swing in favour of the single currency.The context for these currency observations matters. Morgan Stanley has simultaneously revised its Federal Reserve outlook, pushing back its forecast for two quarter-point cuts from September and December 2026 to January and March 2027. Chief economist Michael Gapen cited the April FOMC meeting as the catalyst for the change, noting a clear drift within the committee away from an easing bias toward a more neutral policy stance.The meeting produced three dissents from members who wanted the easing bias removed from the statement entirely, and the FOMC upgraded its inflation language from "somewhat elevated" to "elevated." Gapen was direct in his assessment: disinflation now requires proof, the economy is strong enough to be patient, and policy is already close to neutral, reducing the urgency to act.Morgan Stanley's revised terminal range is 3.0% to 3.25%. The path to cuts relies on core inflation decelerating as tariff pressures fade, shelter costs cool and seasonal factors bear down on sequential inflation readings in the second half of 2026. The key risk, Gapen acknowledged, is energy. If oil prices stay elevated without normalising, spillovers into core inflation could delay the easing cycle further than the bank currently anticipates. This article was written by Eamonn Sheridan at investinglive.com.